NEW YORK--(BUSINESS WIRE)--U.S. Real Estate Investment Trusts (REITs) have deleveraged and strengthened their respective credit profiles over the past three years, but positive ratings momentum may decline according to Fitch Ratings. Fitch's U.S. REIT upgrade/downgrade ratio has been approximately 10:1 from the beginning of 2011 to present, but deleveraging initiatives are largely complete and credit metrics may soon reach an inflection point.
During the depths of the global financial crisis, REIT bond spreads widened materially both on an absolute basis and relative to non-financial corporate and industrial indices. The significant underperformance of U.S. REIT bonds captured deteriorating property fundamentals, a lack of liquidity, and the mandate to pay out 90% of income in dividends to the detriment of bondholders. Following this tumultuous experience, REIT management teams made a concerted effort to deleverage, improve portfolio quality, and de-risk business models. These efforts have been buttressed by improving property fundamentals as evidenced by rising occupancies, rental rates, and net operating income.
As a result of these improvements, U.S. REIT bond performance as measured by effective yields has been strong compared to both non-financial corporates and industrials. REITs trade in line with industrials and 21 basis points inside of non-financial corporates despite trading 56 basis points wide to industrials and 52 basis points wide to non-financial corporates on average over the most recent 10-year period. General corporate credit fundamentals have been slow to improve due in part to equity-friendly behavior including dividend and stock buybacks, offset by accretive refinancing, and improving liquidity.
Stock buybacks have recently become a hot topic for REITs as share prices underperformed other major indices in 2H13 and with many REITs trading below consensus net asset valuation. Should issuers fund sizable stock buybacks with debt or asset sales, credit fundamentals would deteriorate. Given that equity investors generally favor strong, investment-grade balance sheets, Fitch believes the improvement in REIT credit over the past several years is a secular change. However, rising interest rates and growing development pipelines support a stable outlook for the sector.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.